Sunday, December 23, 2012

Commentary: The quest for crowdfunding enters a complicated, but critical phase

Since President Obama signed the Jumpstart Our Business Startups Act last spring, the most successful crowdfunding campaign — for an e-paper wristwatch called Pebble Watch — raised $10 million. Another campaign — this one for a video game, raised $6.3 million from 90,000 fans online — shows that companies with innovative products and services can raise significant amounts of money online.

In about six months, the beleaguered Securities and Exchange Commission will put forward rules that will govern how companies can raise equity capital using crowdfunding.

It has been slow going. The SEC, staggered by its role in the financial crisis, is extraordinarily cautious now. The agency remains under the influence of the industry it regulates, which is frightened by crowdfunding. Industry officials have built obstacles in the SEC’s path to creating crowdfunding rules.

Critics of crowdfunding say that the risk of fraud is high, but their case is weak given that individual dollar investment amounts allowed under the JOBS Act are so small that it would take hundreds of years for crowdfunding to cost the American people the $17 trillion they lost at the height of the financial crisis.
Further, the risk of fraud can be managed by any number of financial instruments designed to do so. Supporters of the movement, for instance, have developed something called the crowdfunding put option, which would allow investors to sell securities back to the seller if fraud is uncovered.

Participants are also likely to sound the alarm if they spot problems. Supporters already have uncovered a potential flaw in the crowdfunding process that might give rise to significant fraud. Rather than discuss this publicly, we have warned the two largest crowdfunding platforms. We will wait to spell out what that flaw is, since we do not want to encourage frauds and seek to protect this new marketplace.

In other words, we (supporters of the crowdfunding movement) got this.

Here is what I think the SEC must do now: Broaden the base. At its forum on small-business capital formation last month, where crowdfunding rules were discussed, the SEC did not have a single African American on any panel. It is important to get participation and perspectives from many communities.
Currently, securities lawyers, another group affected by crowdfunding, have a stranglehold on the rules process. The SEC needs to, again, get input from multiple stakeholders, not just the legal community. This is a time for flexible, open and market-based crowdfunding rules and standards.

The SEC also must be willing to stand up to financial industry interest groups, which also threatened by crowdfunding and have obstructed action.

The JOBS Act is designed to reopen American capital markets to small companies, in part via crowdfunding. Like open source software, crowdfunding is simply open source financing. The regulations required by the JOBS Act are clear.

So is the task before the SEC. Let’s hope the agency doesn’t take longer and make this more complicated than it needs to be.